New RapidRatings Stress Test provides early warning for Supply Chain Managers—there is still time to select suppliers with strong financial health.
In March, we ran our first stress test to model potential outcomes of COVID-19 on our clients’ portfolios of public and private suppliers, third parties, borrowers and other counterparties. Please see the first stress test for details on the methodology and results. In this second edition, we analyzed sector-specific impacts to help clients focus on those areas of their supply chain which exhibit potentially deeper and more prolonged impacts of the current crisis. Instead of applying a flat 15% revenue decline across all industries, which we did for Stress Test 1, Stress Test 2 was tuned based on analyst consensus views for 2020 revenue impacts for each industry; e.g., the range of revenue changes ranged from greater than 28% declines in Oil & Gas and Transportation to minor 3% increases in Biotechnology and Drugs & Pharma. This yielded a more nuanced view of the extent to which industries were likely to be impacted over the coming year.
When comparing Financial Health Ratings (on RapidRatings’ 0-100 scale), pre- and post-stress test we noted a 21-point average decline for the top 10 impacted industries. To contextualize the change in risk profile, we examine the Transportation sector average FHR , which dropped from 66 (“Low Risk”) to 34 (“High Risk”). The associated probability of default at each FHR is 0.05% and 1.78% respectively; representing an increase of 35x. What this suggests for supply chain managers is that while mitigation plans for the handful of High Risk Tier 1 suppliers may have been manageable pre-pandemic, the risks for a larger group of financially stressed suppliers (and the cascading effect on their Tier 2 and Tier 3 suppliers) requires a more expansive approach to measuring supplier financial health – and that the potential consequences for not doing so are greater.
As you can see from Figure 1 below, the percentage of companies in High Risk and Very High Risk grows from 22% to 47% over the one-year stress test period. Yet, while almost half of the over 38,000 public and private companies included in Stress Test 2 saw their FHR risk level increase, the good news is that about a quarter (26%) of companies maintained a Low Risk or Very Low Risk profile. The takeaway for supply chain managers is that the weakening of suppliers can be anticipated in advance: There is time to work with critical suppliers collaboratively to address mitigation strategies as well as to identify suppliers – at other tiers of their supply chains and externally – with the resiliency to deliver as the disruptions continue.
We now look at sector-specific results of Stress Test 2 in Figure 2. As discussed, while our initial stress test applied a flat 15% revenue reduction across all industries, the revenue percentage change (grey bars) in Stress Test 2 varied by sector.
While there is a direct correlation between the change in revenue and the change in risk, as represented by the FHR (red bars), we can see differences in the impacts on industries. For example, nine industries experienced declines in their average FHR between 17 and 23 points, but the revenue declines varied between 12%-31%. The Business Products & Services and Oil & Gas (Integrated) sectors experienced 19 and 21 point drops in the average FHR from declines in revenue of 12% and 31%, respectively. Conversely, the Oil & Gas (Producers) sector experienced a drop of only 11 points in the average FHR from a revenue decline of 28%.
We now look at impacts across various industries.
A more thorough review of the stress test including industry-specific deep dives are now available in both infographic and report form. Take a look at both resources here and if you need a stressed analysis of your industry or your suppliers to get a better view of potential impact, reach out to us at email@example.com.